Securitization in the banking industry is the process of turning an asset—especially an illiquid asset—into marketable securities. In the context of the insurance sector, securitization would imply the conversion of underwriting cash flows into tradable financial securities and the transfer of underwriting risks to the capital markets through the trading of such securities.
By moving the risk to the capital market through financial instruments or derivatives, securitization would increase an insurer's capacity for underwriting. The insurer can use securitization as an alternative to reinsurance, where the risk is transferred via the capital market to a larger group of investors who are ready to accept the risk rather than to the reinsurer. Through capital markets instruments, very high risks can be converted to several small instruments making investment affordable for all size of investors.
With the aid of investment banking, insurance companies can also set up a Special Purpose Vehicle (SPV) to speed up the securitization process. The cost of insurance will decrease because of the risk being transferred from the insurance firm to the capital market, where it is now distributed among a much greater number of investors as compared to the reinsurance. Lower cost of insurance will make insurance more affordable and help increasing the insurance penetration and density which in turn will make insurance more affordable.
Nonetheless, the securitization process needs to be carefully supervised by the insurance regulator as well as the capital market regulator due to the scenarios during the 2007–2009 crisis. In order for investors to comprehend and select the risk properly, insurance companies can publicly disclose the risk profile, rating, claim history, and other crucial details. While deciding between securitization and reinsurance, the cost of the investment as well as the return to the investors must be considered.
As there hasn't been as much work done on securitization in the insurance sector as there has been in the banking sector, insurance businesses can benefit from case studies and expertise from the banking industry before beginning a full-fledged securitization in the insurance sector.
References:
https://www.casact.org/sites/default/files/2021-02/pubs_dpp_dpp99_99dpp133.pdf